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Tax Exemption for Health Benefits On Its Last Legs?

David Godow
November 30, 2010, 9:10am

Though it's uncertain whether the next Congress will enact meaningful budget reform, there's reason to believe that once sacrosanct tax benefits could soon be canceled in the name of deficit-trimming. Yesterday, the AP spread the word that a deal to axe the tax-exempt status of employment-based health insurance benefits may be possible.  This would make employers' contributions to their insurance plans count as taxable income for employees, cutting off a much beloved subsidy and potentially bringing the federal government over $100 billion in previously foregone income taxes.

The exemption has come under fire from budget reformers not only for its direct cost to the government, but for the way it may actually increase health care costs for the general population. By not taxing employer-provided health insurance benefits  in the same way as wages, it effectively subsidizes those benefits. As a result, eligible taxpayers face less than the full cost of their insurance, encouraging them to demand more generous benefits than they could afford themselves. Higher demand, of course, fuels higher prices for health care. Thus, while the exemption might make health care more affordable for certain families, it likely also contributes to the more general rise in health care costs bemoaned by politicians on both sides of the aisle.

It's also uncertain whether the benefits of the subsidy are even concentrated among those who can least afford health care. As this report by the Health Policy Consensus Group notes, the rich enjoy a greater share of the subsidy since they "demand the most expensive health coverage and medical treatments." Those who don't receive health insurance through their employer because, say, they are low-wage hourly workers, see no benefit whatsoever.

There's no doubt that the health benefit tax exemption is popular - and why shouldn't it be? It subsidizes  a product many consider vital. But policymakers shouldn't allow that to obscure the toll it takes on our fragile budget, nor the fact that it may actually increase health care costs in the aggregate. That policymakers have started tacitly acknowledging the exemption's problems is encouraging - let's hope the prognosis stays good.

Addendum: As a reader noted, this post could be read as an endorsement of revoking the tax exemption on health insurance benefits without an accompanying reduction in marginal income tax rates - i.e., simply a tax hike. Certainly any tax hike that results from eliminating tax expenditures should be matched with a reduction in marginal rates, making sure the overall outcome is revene neutral.


David Godow is Research Assistant


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